Does Size Matter? Value Investing in Mid Caps

As value investors, we’re always on the lookout for the investments with the best risk-adjusted returns. So, I asked myself, are the best deals found in the small, mid or large cap stocks?

I started searching for an answer to that question at a time when I needed to add a dimension of growth to my portfolio. The new position would need to deliver potential returns above the market benchmark, S&P 500, with a relatively small increase in investment risk.

When it comes to market capitalization, I’ve found that the size of the companies does not determine their performance. Value investors exposed to S&P MidCap 400stocks have had long-term outperformance over large and small cap companies.

Less Risky than Small Cap Stocks, Greater Growth Potential than Large Cap

With a total market capitalization of between $1.4 billion and $5.9 billion, mid caps generally have a more muscular growth profile than large caps. Mid caps also come without some of the investment risk associated with small cap companies. Risks such as those related to navigating the start-up phase of the business cycle.

Mid cap stocks, however, get distinctly less interest from the large institutional investors. So it goes without saying that Wall Street analysts give them far less coverage. As a result, it was more difficult to confirm my own analysis. That is one important area of risk that increased. So it became even more crucial that I stick closely to my overall investment strategy.

Compelling Evidence for Long-Term Value Investing

Even through the roughest parts of the last 2 decades, the bursting of the Dot-com bubble (1997-2000) and the financial crisis (2007-2008), as a group, S&P mid caps have come out on top. The relative return, when compared to the S&P SmallCap 600 and S&P 500, is astonishing.

More interesting, the divergence between the returns from large cap and those of mid cap significantly widens as the time horizon increases. This is a set-up for the ideal conditions I look for as a long-term value investor. Volatility becomes less important as a factor to consider when taking my investment decision. Along with beta mitigation, there is the greater probability of a return higher than the benchmark S&P 500.

Below is one piece of evidence, recently updated, I used back in 2013 to make a decision on a long-term mid cap ETF allocation.

I will write about the specific ETF I bought in a future post. I’m interested to hear about different criteria you have used when investing in mid cap stocks.

While investment strategies are personal, and this investor discussion forum doesn’t give investment or financial advice, there are some common tenets of value investing that can be better understood by structured and focused discussions with other like-minded investors.